Mindset of a Winning Trader—Fear and Hope
When you ask someone who does not actively follow the markets to describe how the markets work, you are likely to initially be met with a blank stare. While a great number of people have their retirement plans based on the financial markets, it is likely that very few have spent any time thinking or analyzing why the markets go up and down.
If you press these individuals further, you are likely to get a variety of answers relating to the fundamentals of companies and/or larger economic conditions of the country. Common answers will be, "stocks move up because the companies are profitable and show constant growth" or "the market moves up or down based on how the economy is doing." These simplified answers have a great deal of truth to them, but they certainly do not paint the entire picture.
On October 9, 2007, the Dow Jones Industrial Average closed at a record high of 14,164. Less than 18 months later on March 9, 2009, it would close at 6,547. At the time of this writing, the Dow is hovering around the 12,000 level. Such dramatic volatility within a four-year timeframe should provide a clear example that market movement is not solely based on company fundamentals. There is something far less tangible than a company's quarterly report that causes such large swings in the market. While they come in many forms, the two most common of these intangible causal factors are fear and hope.
Hope
One could argue that the entire premise of modern-day retirement accounts is sold on the idea of hope. Individuals invest now on the hope that their money will escalate in value, so later, they will be able to comfortably retire. Individuals hope that the market will go up over the year; they hope that the economy remains stable; they hope that their hope is well founded.
At times, hope manifests itself in such a way that it becomes painfully obvious to the astute observer. Alan Greenspan, in a speech given during the dot-com bubble of the 90s, coined the term "irrational exuberance" to describe the emotions behind hope that drive a market to escalated values that are not backed by financial reality. When a market has been driven to these artificial values, at some point, hope will give way to its ugly sibling—fear.
Fear
Hope can take time to form in a market, and when it sets in, the market generally makes a slow and steady climb upward that sometimes can last years. Fear takes far less time to do its damage. When fear sets in, you can see dramatic drops in a very short timeframe.
Fear can also have a snowball-type effect. In September 2008, it became evident that the financial crisis that had been driving the markets lower in previous months was more serious than originally thought. The market was crippled with fear in the following months, and went on a long slide to its low point of 6,547 on March 9, 2009. Many investors simply couldn't take the losses anymore and sold off, which only led to more fear and continued the slide downward.
Fear, Hope, and Your Trading
While hope and fear definitely fuel the markets at times, they can impact the investor in his or her daily decisions. A little self-awareness can go a long way to improve your overall trading. Depending on your personality type, you may be more likely to be susceptible to the pitfalls that hope and fear can bring than a trader who bases their trades solely on technical analysis. If you are more susceptible to letting hope and fear interfere with your trading decisions, then you need to figure out whether you are a glass-is-half-full or glass-is-half-empty type of individual.
The Glass is Half-Full Trader
This type of trader sees unlimited potential in their trade setups. When they set their targets, they might be a little too optimistic. This type of trader is susceptible to continue a profitable trade further than they should, even though their indicators and the chart show that it is time to exit.
If this was the only problem the emotion of hope created, then we could live with it. However, even more dangerous is when a trade does not start off as anticipated. While no trader ever has a perfect batting record, none of us like losses. When the trade does not materialize as expected and our actual or theoretical stop has been reached, there is the temptation to continue on with the trade a little longer to see if it corrects course. If the trader crosses this line, they have entered the world of pure hope—they have left the world of technical analysis and entered the world of gambling.
The Glass is Half-Empty Trader
Perhaps the most paralyzing thing that fear does to the technical-analysis trader is that it creates inaction. Those traders that let fear take hold will ignore trades that should be made. There is nothing wrong with taking your time and being selective; however, if you find yourself never actually taking action, then you know you are letting fear take over. If you are unsure, set a weekly goal for the number of trades you think you should participate in. If, by the end of the week, you are far under this number, then you may be are succumbing to fear.
Fear can also take hold when a trade is going well. For example, you may find yourself in a trade that is on target to make money. Your indicators and analysis may indicate that there is no reason to exit the trade, yet you exit. Fear can manifest itself as you worry that you should exit now despite no evidence that you should. So desperate to capture the small profits that are on the table, fear can cause this type of trader to ignore their training, and thus forgo larger profits. Fear truly limits what this trader can earn and become.
Hope and fear are real emotions that directly influence the markets and investors. The first key as an investor to combat hope and fear is to analyze objectively what role they play in your trading. Once you have identified how hope and fear affect your trading, then you can work toward making decisions based on sound technical analysis. If a trader can minimize these emotions, then they increase their chance of becoming a successful trader.